Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Zhejiang Jingxing Paper Joint Stock Co., Ltd. (SZSE:002067) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Zhejiang Jingxing Paper Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Zhejiang Jingxing Paper had CN¥2.03b of debt, an increase on CN¥1.77b, over one year. However, it does have CN¥1.21b in cash offsetting this, leading to net debt of about CN¥815.8m.

How Strong Is Zhejiang Jingxing Paper's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Jingxing Paper had liabilities of CN¥1.54b falling due within a year, and liabilities of CN¥1.26b due beyond that. On the other hand, it had cash of CN¥1.21b and CN¥1.04b worth of receivables due within a year. So its liabilities total CN¥542.3m more than the combination of its cash and short-term receivables.

Given Zhejiang Jingxing Paper has a market capitalization of CN¥4.94b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Zhejiang Jingxing Paper has a quite reasonable net debt to EBITDA multiple of 1.9, its interest cover seems weak, at 2.5. The main reason for this is that it has such high depreciation and amortisation. These charges may be non-cash, so they could be excluded when it comes to paying down debt. But the accounting charges are there for a reason -- some assets are seen to be losing value. In any case, it's safe to say the company has meaningful debt. We also note that Zhejiang Jingxing Paper improved its EBIT from a last year's loss to a positive CN¥100m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Zhejiang Jingxing Paper will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Zhejiang Jingxing Paper burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Zhejiang Jingxing Paper's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. But on the bright side, its ability to to handle its total liabilities isn't too shabby at all. When we consider all the factors discussed, it seems to us that Zhejiang Jingxing Paper is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Zhejiang Jingxing Paper you should be aware of, and 1 of them is potentially serious.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.